Some inconvenient facts on equalization

Some inconvenient facts on equalization

Ken Boessenkool

As appeared on page A5

Never let an inconvenient fact get in the way of a good argument. That appears to be the approach of some provinces when discussing potential changes to Canada‘s equalization program. This approach is made easier by the fact that equalization is an extremely complicated and dysfunctional program.

Equalization in principle is rather straightforward — it takes money from all Canadians and distributes it to provincial governments with comparatively weak revenue streams, so that provinces have comparable revenues from which to offer comparable public services.

The federal government has said it will fix equalization, and most reports indicate it will rely heavily on the recent O’Brien report — named for its chair, Al O’Brien, who was Alberta‘s deputy finance minister for many years.

Among other things, Mr. O’Brien recommends changes in the treatment of resource revenues — revenues from oil and gas, forestry, potash and hydroelectricity. Since 1981, equalization payments have been calculated using all resource revenues, except for those from Alberta (the province with the strongest revenue stream) and the Atlantic provinces (four provinces about equal in size to Alberta with relatively weak revenue streams). By excluding Alberta, the formula effectively includes somewhere between one-quarter and one-third of resource revenues in determining equalization payments.

The O’Brien report suggests simplifying this by doing two things. First, it proposes lumping all types of resource revenues together — an important simplification. Second, it proposes including half of all resource revenues from all provinces in the calculation of equalization.

Believe it or not, this second point is where some provincial governments get nervous and make three popular arguments against including resources in the calculation of equalization.

The first argument is a good one — provinces do, and should, have constitutional ownership over resources. But there are two inconvenient facts in this context. First, equalization per se has little to do with ownership of resources. Ottawa is not proposing to levy new royalties on oil and gas, potash, or hydroelectric resources. Resource revenues will be used to calculate provincial allocations under equalization; they will not be used to pay for these allocations. And second, Mr. O’Brien is not recommending any change to current practice — resource revenues are currently included, and he says they should continue to be.

The second argument is rubbish. If the cost of equalization increases, a Newfoundlander earning $100,000 will pay exactly the same for equalization as an Albertan making $100,000. Equalization is paid for out of money that Ottawa collects from all Canadians — it is not a transfer of money from Alberta to Quebec. Alberta transfers too much money to other provinces, but this is more the result of programs such as Employment Insurance and regional pork-barrelling than it is the result of equalization.

The third argument is an appeal to principle. And there is a very good principled argument to make for excluding resource revenues from equalization. Resource revenues are not the same as income tax or sales tax revenues. They are, to use accounting terms, more like the proceeds from the sale of a capital asset than they are revenues from operations. And just like the baker who uses the proceeds from the sale of his oven to pay his employees will soon go broke, so resource revenues should not be spent and considered part of annual government revenues. Hence, resource revenues should not be part of the equalization calculation.

Now, you would think that provinces that appeal to this principled argument — most often Alberta and Saskatchewan — would demonstrate that belief in their own actions. But they don’t.

During the past 10 years, Alberta has used half of its resource revenues to pay down debt, and has spent the other half. In other words, Alberta has only treated half of resource revenues as proceeds from the sale of a capital asset. Saskatchewan, by comparison, has put less than a third of its renewable resource revenues against debt, and spent the rest.

So if Ottawa followed Alberta‘s lead, it would include half of all resource revenues in the calculation of equalization — exactly what Al O’Brien recommends. It would include even more if it followed Saskatchewan‘s lead.

Rather inconvenient facts for these O’Brien report skeptics.

Ken Boessenkool, general manager of Hill and Knowlton Alberta, has written numerous research papers on equalization for the Atlantic Institute for Market Studies and the C. D. Howe Institute.